The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Exacompta Clairefontaine S.A.'s (EPA:EXAC), to help you decide if the stock is worth further research. Exacompta Clairefontaine has a P/E ratio of 10.7, based on the last twelve months. That corresponds to an earnings yield of approximately 9.3%.

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See our latest analysis for Exacompta Clairefontaine

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Exacompta Clairefontaine:

P/E of 10.7 = €118 ÷ €11.03 (Based on the trailing twelve months to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each €1 of company earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Exacompta Clairefontaine shrunk earnings per share by 3.0% last year. But over the longer term (5 years) earnings per share have increased by 24%.

How Does Exacompta Clairefontaine's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (11) for companies in the forestry industry is roughly the same as Exacompta Clairefontaine's P/E.

Exacompta Clairefontaine's P/E tells us that market participants think its prospects are roughly in line with its industry. The company could surprise by performing better than average, in the future. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

So What Does Exacompta Clairefontaine's Balance Sheet Tell Us?

Net debt totals just 2.3% of Exacompta Clairefontaine's market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.

The Bottom Line On Exacompta Clairefontaine's P/E Ratio

Exacompta Clairefontaine has a P/E of 10.7. That's below the average in the FR market, which is 17.6. With only modest debt, it's likely the lack of EPS growth at least partially explains the pessimism implied by the P/E ratio.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. Although we don't have analyst forecasts, shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.